Saradha chit fund scam: State government failed, but so has centre

The thrust on financial inclusion should help, but that will also need a well incentivized distribution structure that will encourage organized sector savings.

NEW DELHI: The apparent cause of the Saradha Group of West Bengal going bust is lax regulation of the chit fund sector, which falls under the ambit of states, but there is a larger systemic reason that has led to proliferation of these disguised ponzi-schemes.

Over the years, the change in marketing and distribution incentive structure for financial savings that discouraged sale of small savings products and mutual funds created a void filled quickly by fly-by-night operators that enticed gullible investors with high returns.

In the late 1990s, the US-64 scheme of the UTI with its vast network of sales agents was a popular saving option for investors along with the insurance policies of the Life Insurance Corporation of India. Pushed by an army of agents, the small savings of post offices provided another set of option to investors who did not have access to regular banking services.

In 1991-92, investments in UTI units, other MFs and small savings added up to nearly a quarter of household savings in financial assets. Life insurance funds accounted for another 9.4%.

The collapse of the US-64 in the early years of new millennium did not impact the savings habits much as by the time private sector mutual funds had spread their wings and small savings were easily accessible.

Things changed in 2007 when Sebi abolished entry load on direct investments, without the intervention of any sales agent, and subsequently abolished it altogether in 2009. The change meant that sales agents did not have any incentive to pitch MFs to investors.

Two years later, in 2011, the government drastically reduced commission on many of the small savings schemes and abolished it altogether for popular ones likes the Public Provident Fund. Almost overnight agents disappeared from post offices, and switched to selling insurance, where commissions are still high.

The numbers for 2011-12 show net redemption from small savings and shares & debentures but the usually missold life insurance had a 23.1% shares.

Of course, there were other factors as well like allure of gold, high inflation, higher rate of interest on bank deposits and lacklustre stock markets. That the government has restored commission on mutual funds is an admission of the error. The lack of push for regular savings products and allure of quick and high returns has caused the proliferation of chit funds, and the weak regulation has helped.

The thrust on financial inclusion should help, but that will also need a well incentivized distribution structure that will encourage organized sector savings.